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Netflix: Competition Fears Seem Exaggerated

Annual results of the FAANG (Facebook (FB), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Alphabet (GOOG)) stocks are definitely among the most sought-after events for investors.

Netflix released its results earlier this week, and financial news websites are filled with both bullish and bearish views on the stock. Of all the FAANG stocks, Netflix can arguably be considered the one with the most divided opinions among the investor community. The stock went through a fall caused by investor fears associated with rising competitive threats from other global media giants, only to revive again. Given this background, it is interesting to analyze the company's results, and whether investor fears are reasonable.

Decent results but high cash burn

Netflix recently released its fourth-quarter and full-year results for 2019, where it managed to beat analyst expectations on the revenue and earnings front. For the fourth quarter, the company reported a top-line of $5.47 billion in revenue, a 30.6% jump as compared to the $4.2 billion reported in the corresponding quarter of the previous year and above the $5.45 billion analyst estimate. Its earnings per share of $1.30 was a significant improvement over the 30 cents reported in the previous year, and its net margin improved to 10.7%. The company's paid net membership additions were around 8.8 million; although it underperformed in the U.S. market, it outperformed in the international markets.

For full fiscal 2019, the company has officially reported a 27.6% increase in its top-line, driven by a 20% increase in paid memberships. Netflix also reported a higher operating margin of 12.8%, and the management expects this number to grow to 16% in 2020.

The only drawback is that the company has been bleeding cash (about $3.3 billion of negative free cash flow for the year) and was forced to raise $1.0 billion via 4.875% senior notes and EUR1.1 billion British pounds (approximately $1.21 billion) via 3.625% senior notes to fund the cash burn. These notes are due in 2030 and add to the debt level of the company, which is nearly at $14.8 billion and is certainly on the higher side.

The above chart throws some more light on the company's debt level and its simultaneous growth along with the stock price. While the stock may have appreciated by 151% in three years (of which the appreciation in 2019 was hardly 3%), the long-term debt level has also increased by 127% to fund the cash burn. The management expects an additional $2.5 billion of negative free cash in 2020, which means higher debt and more gearing. However, the debt to EBITDA ratio of 1.23 implies that the management still has a lot of leeway in this regard.

Is Netflix's Business that badly affected by competition?

It is a fact that Netflix has been facing competition from other streaming services, the largest one being Amazon Prime. Prime has not been the company's only concern, as the local media giants in most countries of the world are countering Netflix with their own streaming services and original content. Disney+ (DIS), Apple TV (NASDAQ:AAPL), Disney's Hulu and AT&T (NYSE:T) are examples in the U.S. that have seen some good subscriber growth ever since they launched their own streaming services. Disney+ gained close to 25 million subscribers with plans priced at $6.99 per month or $69.99 per year. No doubt, Disney is a formidable competitor, with solid content and production capabilities backed by studios like 20th Century Fox, the Marvel Universe, Lucasfilm and more. Apple TV is also reasonably priced at $4.99 per month.

Analysts believe that Netflix's moat is possibly shrinking, but then again, this was something that was foreseen by the management. CEO Reed Hastings and his team were well aware of the single largest problem associated with their business model - the ease of replication by media companies with deep pockets. This is the reason why Netflix has been focusing on building better quality of content. The company's original content has gained widespread viewership in the previous year, with series like The Witcher (streamed by over 70 million households), The Crown (a 40% higher viewership for the third season as compared to the second one) and movies such as The Irishman and Marriage Story (Oscar nominees). This clearly demonstrates Netflix's ability to produce high-quality content that is engaging and gives a good enough reason for subscribers to not cancel their memberships.

Key takeaways

In the end, there are two questions to answer here. Does Netflix have the same kind of pricing power as before to over-charge customers and boost its revenues? Maybe not, after the arrival of such strong competitors. However, does that mean that Netflix will start losing its subscriber base? Probably not, assuming that the company keeps churning out high-quality content and stays focused on the production aspect as well. One must remember that at the end of the day, the streaming services market is not a zero-sum game. Assuming that streaming services continue to be as cheap as they are today, many Americans wouldn't mind paying the annual subscriptions of Netflix, Disney and Apple TV. After the strong financial result and the continuing subscriber growth in international markets, I believe investors should not fear to hold on to the Netflix stock.

Disclosure: No positions.

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